Price Discrimination
1. Suppose a firm can perfectly price discriminate. What is the lowest price it will charge, and what
will its total output be? (1 point)
2. When pricing automobiles, American car companies typically charge a much higher percentage
mark-up over cost for “luxury operation” items such as leather trim, etc., than for the car itself or
for more “basic” options such as power steering and automatic transmission. Explain why. (1
point)
3. Price discrimination requires the ability to sort customers and the ability to prevent arbitrage.
Explain how the following can function as price discrimination and discuss both “sorting” and
“arbitrage” in your answer. (3 points)
a) Requiring airlines travelers to spend at least one Saturday night away from home to qualify
for a low fare.
b) Insisting on delivering cement to buyers and basing prices on buyers’ locations
c) Charging high-income patients more than low-income patients for plastic surgery.
4. A monopolist is deciding how to allocate output between two markets. The two markets are
separated geographically (East Coast and Midwest). The monopolist’s total cost is TC = 5 + 3(Qa +
Qb), and thus, MC = 3. The monopolist’s demand and marginal revenue for the two markets are as
follows below. Calculate the monopolist’s price, output, profit and the deadweight loss to society if
s/he can price discriminate. (2 points)
Pa = 15 – Qa; MRa = 15-2Qa
Pb = 25 – 2Qb; MRb = 25 – 4Qb
5. Many retail video stores offer two alternative plans for renting films:
Two-Part Tariff: pay an annual membership fee (e.g. $40) and the may a small fee per film
rented (e.g. $2 per film per day)
Straight rental fee: pay no membership gee but pay a higher daily rental fee (e.g. $4 per film).
Why do you think the store might offer the two-part tariff? Why offer customers a choice rather
than merely offering the two-part tariff? (1.5 points)
6. Sal’s satellite company broadcasts TV to subscribers in Los Angeles and New York. The demand
and marginal revenue are below. The TC of providing Q units of service is given by TC = 1000 +
30Q, and MC = 30. What are the profit maximizing prices and quantities for the New York and Los
Angeles markets? What would happen if people in LA were able to receive Sal’s NY broadcasts
and vice versa due to a new improved satellite? (1.5 points)
Pny = 150 - 3Qny MRny = 150-6Qny
Pla = 120 – 3/2Qla MRla = 120 – 3Qla
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